This thesis provides insight into the risk management tool XVA. The purpose is to provide an overview of why it is necessary to adjust for selected factors and the consequences if you do not. The introduction of XVA started primarily after the financial crisis in 2008. At that time financial institutions were considered impossible to default which resulted in neglecting the counterparty credit risk (CVA). The years following the financial crisis were led by justifiably regulations to the financial sector, to insure a larger focus on liquidity and capital requirements. Banks are one of the pillars of society. Financial institutions provide money management, facilitate cash and credit in the economy and transfer and mitigate economic risk. Comprehensive risk management is critical to ensure the public’s trust, as mistrust would lead to decline in economic growth. The interbank market provides liquidity and cash and is a global loan market where market participation is key to ensuring favorable rates when funding is needed. The Rangvid report was constructed after the financial crisis and highlights the key factors that contributed to the worsening of the crisis in Denmark. Methods of the analysis includes quantitative calculations of interest rate swaps in a bilateral scenario. Analysis of the results show that adjustments are needed. The swaps will give a clear understanding of why it is necessary to adjust for credit value adjustment (CVA) and funding value adjustment (FVA) in terms of assessing the correct trading book value. Other analysis includes collateral agreements with counterparties as an instrument to risk management. Potential pitfalls in these agreements will also be analyzed. Analysis of the Black Scholes pricing model is therefore relevant for this thesis to investigate in order to understand the assumptions of CVA, DVA and FVA. Calculating four different call options on big American conglomerates in unilateral scenarios will provide the needed insight into the model. Based on this insight it is the purpose of this thesis to make XVA comprehensible. As a conclusion, the findings from both the interest swap and the call options show a clear need for XVA. The factors that this thesis has limited itself to (CVA, DVA and FVA) justifies their existence. However, is it pointed out that the assumptions behind the XVA calculations are difficult to analyze. The subcomponents of the CVA, DVA and FVA are impossible to calculate accurately because of the model-based approach of estimating the factors.
|Educations||Graduate Diploma in Finance, (Diploma Programme) Final Thesis|
|Number of pages||92|